Many investors are looking for the next great deal. But before putting your money into something new, it is essential to understand what it is and the pros and cons of buying it. ETFs, or Exchange Traded Funds, are in the news a lot right now due to the GameStop frenzy earlier this year peeking investor interest in particular ETFs. Let’s explore ETFs so you can decide if they may be a good fit for your portfolio.
What is an Exchange Traded Fund (ETF)?
According to NerdWallet, ETFs “are a type of investment fund that offer the best attributes of two popular assets: They have the diversification benefits of mutual funds while mimicking the ease with which stocks are traded.” ETFs are called “exchange-traded” because they are traded on an exchange, just like a stock, susceptible to the same daily fluctuations in price as shares are bought and sold on the market.
ETFs can contain many different investments such as stocks, commodities, and bonds with varying levels of risk. As always, it is important to do your research on particular holdings before investing.
How Do ETFs Work?
Here is an abbreviated explanation from NerdWallet:
An ETF provider considers the universe of assets, including stocks, bonds, commodities, or currencies, and creates a basket of them with a unique ticker.
Investors can buy a share of that basket, just like buying shares of a company.
Buyers and sellers trade the ETF throughout the day on an exchange, much like a stock.
You can purchase ETFs through online brokers and traditional broker-dealers.
What Are the Advantages of ETFs?
Diversification
ETFs include not only a variety of investments such as stocks and bonds, but they can also encompass a wide array of industries and sectors, allowing an investor to spread their risk even further.
Easy to research, buy, and trade
Since ETFs trade like a stock, it does not take much effort to research the different holdings of an ETF. Likewise, the price activity of an ETF is easily looked up using its ticker symbol and is available for purchase and trade on many electronic trading platforms like E-Trade.
Tax-efficient
Investors have more control of when they incur taxes with ETFs as, most often, capital gains are only realized when an ETF is sold.
What Are the Disadvantages of ETFs?
Potential for High Cost
Buying and selling shares of ETFs may result in brokerage commissions and may be high, especially for actively managed ETFs.
Lower Yields
Since ETFs typically track a broader market, there’s less volatility on a day-to-day basis which, in turn, can limit the amount of money you can make, especially in short-term trades.
Liquidity
Being able to turn your ETF into cash fast may not be easy. Due to low trading interest in some ETFs, getting rid of it may be difficult.
As with any investment decision, you must do your research. If you feel ETFs may be a good addition to your portfolio, contact us today so we can work with you to determine the best ETFs for you.
